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The Hits Keep Coming for Media Stocks

Disney got the ball rolling downhill on Aug. 4 when it reined in expectations for its cable networks business.

Media stocks were dented again on Tuesday after an analyst downgraded the entire sector arguing that the value is shifting from content to distribution.

"After going through one of the worst earnings seasons we have ever had outside the Great Recession, it's time to re-assess our entire coverage universe as clearly both fundamentals and sentiment have changed," Marci Ryvicker of Wells Fargo Security wrote in her note downgrading the media sector from "overweight" to "market weight."

The analyst says she likes pay TV distributors as terrestrial Internet is increasingly important, but most content providers are problematic, and she specifically downgraded CBS, Walt Disney and 21st Century Fox. She said she still likes Time Warner and to a lesser extent Comcast, though she's not bullish on the latter's NBCUniversal segment because of its cable networks.

Disney got the ball rolling downhill on Aug. 4 when it reined in expectations for its cable networks business, including ESPN, and other conglomerates followed with lackluster earnings and guidance, save for Time Warner.

Ryvicker says in her note that she and her team analyzed historical trading patterns for media companies and re-read all of the recent quarterly earnings reports and transcripts from the conference calls with management. "To be honest, this was really, really hard," she wrote.

She argues that the "diversified entertainment" sector does not have enough offerings that are considered "must-have" by the average consumer; that there is too much foreign-exchange risk; the sector lacks potential for positive catalysts; and that government regulation could pose problems.

All of the major media stocks have been trending down since early August when Disney reported its quarterly financials, and they all sunk lower Tuesday, as well: Disney and Viacom were each off 2 percent while Fox, Comcast and CBS were each down 1 percent. Time Warner was off fractionally.

Ryvicker says total household primetime ratings at the eight biggest cable networks conglomerates dropped an average of 7 percent in the most recent quarter, 9 percent in the quarter before that and 12 percent in the quarter prior to that, so it's no surprise ad revenue is strained, but a newer problem is that affiliate growth is also under pressure.

"What seems to have really shaken the market is the fact that we are finally seeing the fraying of the television ecosystem in affiliate fees — which is just tough, as subscription revenue is supposed to be the most stable and the highest margin of any media-type revenue stream," Ryvicker wrote.

Of the three stocks she specifically downgraded, she said she "struggled" with Disney, given catalysts like upcoming Star Wars movies and a theme park in Shanghai. While her team and their kids "love Disney as a company," the numbers no longer justify an "outperform" rating, she says.

She also says Fox was "tough" to downgrade because it has the "best growth prospects within the media sector." That said, she doesn't see the conglomerate's Regional Sports Networks being prominent in skinny bundles and she does not see how TV advertising going forward can be flat, as management indicates, after significant ratings declines.

As for CBS, Ryvicker acknowledges she "hands down" likes broadcast over cable networks, but she doesn't like how earnings estimates keep coming down. Wall Street estimates CBS will earn $3.42 per share this year while a few months earlier estimates were for $4.16 per share.

"Now we recognize that CBS has the Super Bowl and Thursday Night Football again in 2016, and there is also this event called the presidential election — all of which should help demand, but this is probably already accounted for in the Street models," she wrote.

Wall Street, though, is not a monolithic community, so the same day Ryvicker downgraded media, Barton Crockett of FBR & Co. issued a lengthy note reiterating some of his "outperform" ratings because he sees opportunity in falling stock prices.

He's bullish on CBS due to rising retransmission fees and prospects for its recently released Showtime streaming service. He likes Disney because its brands "have unrivaled appeal online," ESPN's audience is "durable" and Star Wars and a Shanghai theme park are coming.

He's bullish on Time Warner because of a "positive affiliate fee cycle" and "surging popularity" for the HBO streaming service. And he likes Viacom because it is the cheapest of the conglomerates, selling for just seven times its forward price-to-earnings ratio. He also says a breakup of Viacom is possible down the road, which would be beneficial to shareholders.